What Is the Worst Kind of Debt?
When looking at our debt it’s important to distinguish between good debt, bad debt, and the worst debt of all. Believe it or not, there are some debts that are actually good. Of course, with the good comes the bad, and at the bottom of the barrel is the downright ugly. Let’s take a look at the different types of debt.
Good debts are debts that add value to your life. They are an investment in your future and they add to your net worth in some way. Usually a good debt pays for itself by being able to add to your future income. So while you might be paying off the debt today, in the long run you’ll benefit financially for it. Some examples of good debts are:
Real Estate – Mortgages are good debts because the interest rates on them are low and houses have a tendency to increase in value over the years.
Student Loans – Getting a degree or diploma is like an investment in yourself and it can increase your earning power in the future.
Business Loans – Business loans are good debts because you are investing in your own ability to keep your business afloat and make it become worth more than the original loan.
Debt consolidation loans – Debt consolidation loans make for great solutions for individuals that have taken on too much high-interest debt. Swapping high interest rate with a lower interest alternative in the end means lower monthly payments for you and more money in your wallet.
Check out our article on good debt.
Bad debts are debts that we incur for things that immediately start decreasing in value and really don’t contribute to our net worth or financial future. If a debt doesn’t have the potential to add to your net worth in the long run, then it’s most likely a bad debt. Here are some examples of bad debts:
Credit Cards – Credit card debts are bad debts because their interest rates are very high. People tend to pay the minimum monthly payment and doing so keeps them in debt for years. By the time they pay off the item they paid for with the credit card, they’ve paid way more than the original cost of the item.
Rent To Own – Having a rent to own lifestyle is a terrible mentality that you don’t want to get into. These days you can rent to own just about everything from televisions, to computers, to refrigerators, to furniture. You could furnish an entire apartment with only rent to own items if you wanted to. The problem with it is that the interest rates for renting to own merchandise are terrible, and by the time you pay the items off you will have paid more than double what they are worth. Now, it is worth noting that we do not believe that renting to own homes falls under the category of a “bad debt” since that type of home purchasing solution helps you acquire an appreciating asset.
Payday Loans – Payday loans take advantage of people in their time of need. They don’t require a credit check, but they do promise a short-term loan with an outrageously high interest rate until your next payday. Of course, after you pay them back you’ll be broke again and have to get another loan from them. They prey on those with bad credit and lure them into a seemingly never-ending sadistic cycle.
Very Short-Term Lenders – Very similar to payday loans, short-term lenders offer loans that are nothing more than a vicious tax on the naïve. They don’t do credit checks, but if you’re willing to take their money, they are willing to charge you ridiculously high interest rates. Instead of payment being due in full on your next payday, they typically spread the payments out over the course of a couple of months. However, they know that because of the high payments and interest rates you’re going to either need to refinance the loan halfway through the term, or get a new loan once you finally finish paying the current one off.
Gambling – Gambling really never increases anyone’s net worth in the long run because although they might be on a winning streak for a little while, everybody’s winning streak comes to an end eventually. When you start losing you keep gambling to try to make up for your losses and before you know it you’re borrowing money just to pay off your gambling debts. Gambling quickly becomes an obsession, then an addiction, and finally a disease. Think of it as throwing your money away, because it’s definitely not a way to grow your assets.
Tax Refund Loans – Some income tax preparation companies will offer you a refund anticipation loan. Typically, after preparing your taxes they will tell you what your tax refund will be, and then offer to give you the money right away for a fee, which of course they will deduct from your refund. The problem with that is that the fee is much higher than what it would normally cost to get your taxes done. Back in the days when we had to snail mail our taxes it might have been worth it. But nowadays with e-Filing it’s worth waiting a couple of weeks to get your full refund in the mail. Another problem with tax anticipation loans is that if they made a mistake and you don’t wind up getting the refund, you could wind up owing them the money.
The Worst Debt
Now that we’ve looked at good debts and bad debts, we still haven’t answered the all important question of what the worst debt is. The worst debt is not one specific type of debt. The worst debt is simply any debt that a consumer can’t pay, especially one with a high interest rate.
Why is the worst debt one that the consumer can’t pay rather than a specific type of debt? The answer to that is simple. If you have a debt that you can’t pay, you could wind up in collections, or with your wages garnished, or in a courtroom. Any single debt on this list, whether on the good debt list or on the bad debt list, could wind up be the worst debt if you can’t pay it.